Why Bearish Market Sentiment Isn't Leading To Bearish Market Performance

Despite potential headwinds, equity markets have been continuing to rise this year. Michael O’Brien, Portfolio Manager with TD Asset Management, explains why in this type of trading environment investors should consider focusing on higher quality assets and a more balanced portfolio.

Transcript

Kim Parlee: Whether it will be economic uncertainty or bank fears, there's no shortage of potentially bearish headwinds fueling uncertainty in these markets. But that hasn't exactly led to a bearish performance. Take a look at this.

Here's a look at the TSX, up just shy of 7%, and the S&P 500, just shy of 10.5%. So where exactly is this sentiment coming from? For more, we're joined by Michael O'Brien. He's portfolio manager at TD Asset Management.

Nice to have you join us. Thanks for coming in.

Michael O’Brien: Yeah, well, thanks for having me on.

Kim Parlee: OK, so headlines, if you look at them, everything's terrible. Markets, which we just looked at, they're kind of shrugging it off. What's happening?

Michael O’Brien: Well, I mean, that might be a big part of it right there is everybody is pretty bearish. Everybody was pretty bearish coming into the year. And you know the old adage, the market climbs a wall of worry. So there's lots to worry about.

So I think one of the explanations is simply positioning. Everybody was cautious. Everybody still is cautious. And the market just likes to stick that in our face sometimes.

I think more tangible reasons in terms of what's been driving the optimism, obviously one of the things investors are desperate to see is for the central banks to go to the sidelines. For the central banks to go to the sidelines, you need to see inflation come back down.

And so to be fair, we've seen some pretty decent progress so far this year. We had an inflation report last week here in Canada that was pretty optimistic, well off our highs. Ditto for the US, inflation is coming down.

The problem is investors, in my opinion, seem to be trying to move too quickly to discount this. It's a long way - so the good news is we've gone from 8% to 4% in inflation. But as the Bank of Canada said last week, it's going from 4% to 2% that's the really tough part.

And yet, investors are kind of hoping and wishing and positioning for that moment where the central banks move to the sidelines and actually start reducing interest rates. Personally, I think they're getting ahead of themselves. I think that's much further off in the future than you would believe if you look at how the markets performed so far this year.

Kim Parlee: That's interesting. Yeah. It's an impatient market. We expect everything now. And some things might be taking a little longer, to your point.

Banking sector, of course, has been fueling a lot of uncertainty, especially in the US, especially the smaller US lenders. What's the implication, do you think, on the Canadian side?

Michael O’Brien: So I think the short answer here is the specific issues that have really got people concerned south of the border with the smaller US regionals revolve around stability of their deposit bases.

If you look at the Canadian situation, very, very different. I'm not concerned about the stability of our deposits. We actually have public data through the end of February where deposits in Canada among the big six are still growing. So I think that that concern isn't applicable.

What we have seen in the last couple days here. Obviously with bank earnings season starting, we've seen a mix of small and large US banks report. So JPMorgan (JPM) and Bank of America (BAC) on the top end, with a number of regionals sort of in the smaller end.

My guess is when the Canadian banks start to report in about a month, later in May, their numbers are going to look a lot more like what we've seen out of the JPMorgans and the Bank of Americas, as opposed to some of the regional banks, which are showing some stress.

Kim Parlee: Hm. Interesting. With all this in mind, I believe-- and I don't want to put words in your mouth - you can tell me if this is true, but you believe people should be taking a cautious approach right now to the markets.

Michael O’Brien: Yeah. Going back to the first part of the conversation, I think the real key question here is how sticky is inflation going to be? And the stickier inflation is, the longer the central banks have to keep restraining the economy, restraining financial conditions.

And so if you look at leadership this year, it's actually been concentrated in things like gold, technology stocks, things like Bitcoin, which typically do really well when central banks are loosening conditions -

Kim Parlee: Yeah, when things are ripping.

Michael O’Brien: When liquidity's coming into the market. So I think we're at odds here. So I'd be a little careful. I don't know that we're getting rewarded for taking a lot of, for being too aggressive in our positioning right now in equities. So I'm trying to bide my time, trying to be patient and focus on other areas of the market than sort of what's been the front page stories.

Kim Parlee: Which has served you well. If you talk about specific names that you find are interesting right now, I know you've got three that you brought to talk about. The first one's Dollarama (OTCPK:DLMAF).

Michael O’Brien: Yeah, this would fall into the bucket, and I think all three of them are kind of symptomatic or good examples of how I'm feeling about the market right now, which is focus on the areas of the market where you see really good quality companies, where I have a lot of confidence that they will deliver the goods operationally. I don't think this is the time to take a flyer on some names where you don't have that same level of trust.

So Dollarama, they just reported last week. Super results. Very sturdy operators. And they occupy such a unique space in the Canadian retail landscape, you know, that value retail proposition. So it's one of those names, they haven't done much this year, as people have been busy buying other stuff, other stocks. So it's the type of name that I like to circle around when people are looking elsewhere. You know, nice, reliable name.

Kim Parlee: It's up 14%, though, on a full-year basis anyway.

Michael O’Brien: On a full-year, yes, absolutely.

Kim Parlee: Intact Financial, (IFC:CA) (OTCPK:IFCZF).

Michael O’Brien: Yep. So another example of a very high quality company and maybe what I would describe as a little bit lower beta within the financial space, property and casualty insurance. So not quite as high drama as what we're seeing out of the banks and also some of the life insurers.

So again, it's another one of these nice, steady, high quality names. The same management team's been running it for years, doing a phenomenal job. Again, off to a pretty slow relative start this year, another name that we're happy to add to.

Kim Parlee: And last one are the rails, which is interesting, CN (CNI) and CP Rail (CP).

Michael O’Brien: Yeah. And I would say this is more of a through the cycle look. Again, some of the higher quality companies, higher quality businesses that we've got in Canada and the Canadian market. CN Rail, really nice turnaround happening there. Their new CEO and their new COO have done a really nice job getting them back on track, so to speak.

Whereas CP Rail, it's a really interesting juncture here. Just last week they closed an acquisition to buy Kansas City Southern. This is a real transformational acquisition. And when you look at CP and Kansas City Southern, the combined network, it's really going to open up a lot of doors for this company.

Kim Parlee: Very interesting. Mike, it's always great having you on. Thanks so much.

Michael O’Brien: All right. Thanks for having me.

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